Seeking Alpha

Fast Food Is Sought After During Hard Times

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Includes: JACK, MCD, QSR, WEN, YUM
by: Christopher VanWert
Summary

Fast food performs surprisingly well during recessions.

We compare the current largest players.

We look for the safest stock in this sector to own.

Thesis

Despite many Americans attempts to eat healthier, when their income is diminished so is their desire to improve their health. Fast food restaurants are an easy outlet for family dinner on a budget when cooking dinner isn't an option. This becomes more prevalent when the heads of the household are both looking for better jobs or for ways to earn extra cash.

Our belief is that the inverted yield curve, historically low unemployment and highest total market cap to GDP since the dot-com bubble has signaled troubled times ahead. Fast food historically has been a decent shelter for recessions.

The companies we're looking at today are McDonald's (NYSE:MCD), Yum! Brands (NYSE:YUM), Restaurants Brand International (NYSE:QSR), Wendy's (NASDAQ:WEN) and Jack in the Box (NASDAQ:JACK). We've purposely selected the largest market cap restaurants that offer the cheapest menu items with the least time commitment. This should be unsurprising given our desire to explore fast food and our economic outlook.

Summary of the companies we're looking at

While many investors' initial thought would be sales of the company's fast food items drive revenue it's not that simple. Many of these companies operate in a franchise structure. Owning the property and licensing the brand through royalties and fees with strict guides on how to operate. These franchises are actively managed by working investors.

McDonald's is a mixture of both company-owned and operated stores alongside franchises. As of this year, they generate most of their revenue from franchisees. This year is the first time its ever happened for McDonald's while publicly traded.

Yum! Brands consists of three major fast food restaurants. KFC, Pizza Hut and Taco Bell. The company operates as a franchiser with only 2% of its stores being company owned. YUM is following the same path as McDonald's. 2018 is the first year that franchise and property revenue eclipsed company sales.

Restaurants Brand International owns three major quick-service restaurants Burger King, Tim Hortons, and Popeyes. Most of its revenue comes from Tim Horton's sales. This is followed by Burger King Franchise and property revenue. As of 2018 revenues from franchise and property has exceeded sales from owned restaurants.

The Wendy's Company is the parent company for the owner and franchisor of The Wendy's restaurant system. In 2008 Wendy's and Arby's merged into one public entity until 2011 when Arby's was spun off and sold to ARG Holding. Prior to 2008, all stock resultants would be from Arby's financials only. Wendy's retained 18.5% until this year when it sold it's last 12.3% (diluted by the purchase of Buffalo Wild Wings) for $450 million in 2018.

Jack in the Box is another quick service restaurant, based out of California. From original Hamburgers to tacos, Jack in the box serves it all. After selling Qdoba to Apollo Global Management, Jack in the Box moved to a franchise focus. However, 51.5% of revenue still comes from Company restaurant sales. Jack in the box hopes to push this percentage down in the future.

Now that we have a high-level idea of what's under each stock, let's look at past performance during recessions.

Stock Performance during recessions

Created by the author from Finance.yahoo.com

During the recession of 2008 McDonald's, Yum Brands and Jack in the box all outperformed the S&P 500. Wendy's was the only fast food franchise that suffered large losses during this time period.

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

While most of these company's financials performed well, Wendy's had a turbulent time. Although it looks worse than it is. Some of the drastic financial changes are due to the merger in 2008. However, its earnings were still volatile over this recession. It's hard to count this against Wendy's when they were just merging over this time period.

Created by the author from Finance.yahoo.com

During the dot com bubble most tracked alongside the market leading into the recession. After the recession starts YUM! Brands took off. Wendy's (Arby's at the time) distributed a large dividend. Accounting for this change Wendy's finished with a similar gain to Jack in the Box.

Current Financial Performance

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Valueline and Finance.yahoo.com

Created by the author using Finance.yahoo.com

Over the last 4 years, almost every one of our fast food stocks has beaten the market. Jack in the box did not and it's clear to see why in the financials. While revenues have been taking a hit due to re-franchising in other fast food stocks, Jack in the Box has been suffering for another reason. Management believes its sales have been driving down by not competing at the right price points (below $5 meal bundles). While they have plans to fix this in the future, its still an outstanding question currently.

Looking at the financial performance of these companies along with their stock performance it's hard to find the best in the group. I'm dropping QSR from consideration only due to lack of financial history, this is despite its good-looking financial trends. I'm dropping Wendy's due to its turbulent past during recessions which make it harder to evaluate during these time periods. Jack in the Box is dropped due to its current financial issues until management can solve their current problems.

This leaves us considering either YUM! or McDonald's.

Created by the author using data from 10-k

Both companies are in a comfortable zone as far as interest coverage goes. However, longtime readers know that I'll always choose the company with less debt. Despite YUM!'s superior stock price performance during recessions, I'm picking McDonald's to sleep even better at night.

Dividend Growth Model of MCD and YUM

We're assuming a 2.6% growth rate base on McDonald's consistent high increases in dividend payouts. McDonald's is currently trading at $203.26 implying an upside of 6.13% from its current level.

Even using a much larger growth rate due to YUM!'s much shorter history, we wind up with less opportunity. YUM! Is current trading at $107.57 implying a large downside using this dividend model. However, YUM!'s current payout ratio is 30% compared to McDonald's 55%

Conclusion

Both YUM! And McDonald's appear to be good investments if we face a recession. McDonald's seems to have better value currently, despite a slightly less optimistic record during recessions when compared to YUM!. There also appears to be a rising trend in revenue generation moving from store sales to franchise-related revenue.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.